After a very calm market in 2017, volatility returned with a vengeance in the first quarter of 2018. The stock market soared 5% in January, setting record after record. Investors, optimistic about the global economy, poured a record amount of money into equity mutual funds and exchange-traded funds. Then in February markets plummeted on fears of rising interest rates. The S&P 500 reached an all-time high of 2872.87 on January 26th but fell more than 10% to 2581 on February 8th. Stocks struggled to regain their footing for the rest of the quarter.

On March 1st, the Trump administration announced steep tariffs on aluminum and steel. These tariffs are aimed mainly at China, as Pres. Trump announced exemptions for Canada and Mexico when the tariffs took effect on March 8th. Several rounds of retaliation have occurred between China and the U.S. since then.

If a full-blown trade war ensues, it could result in slower economic growth and higher prices. Nevertheless, many observers believe that a trade war is not in the best interest of either country and that the end result could be a mutually satisfactory arrangement going forward.

Domestic Equity Markets

The S&P 500 fell by 1.2% and the Dow Jones Industrial Average by 2.5% in the first quarter, while the Nasdaq Composite rose 2.3%. Tech stocks built on their substantial 2017 gains in January and were recovering nicely from the February decline until March 17th. On that day, several reports revealed that Cambridge Analytica, a data analytics firm, had obtained the personal information of around 50 million Facebook users without permission. Facebook fell sharply, dragging other tech stocks down as well. In addition, very late in the quarter, President Trump issued threats to regulate Amazon.

Despite these issues, the technology sector of the S&P 500 rose by 3.5% in the quarter. The only other sector to gain ground was consumer discretionary, while interest-sensitive sectors (utilities, real estate, telecom and consumer staples) fell by an average of 5.7%.

International Markets

International stocks were mixed in the first quarter, with the MSCI EAFE index of developed international stocks down 2.2% while the MSCI Emerging market index gained 1.1%. The strong performance of the Euro currency in 2018 hurt European stocks as the STOXX Europe 600 index fell 4.7%.

While Europe’s economies remain in growth mode, growth in manufacturing cooled to an eight-month low in March, and factory orders in Germany, Europe’s biggest economy, have been far below expectations this year. Meanwhile, emerging markets remain jittery at the prospect of a trade war.

Bond Markets

Rising interest rates have been a big theme in 2018. The U.S. 10-Year Treasury Note ended 2017 at 2.41%, but rose steadily in January and February to a peak of 2.94% on February 21st. Expectations for increased economic growth and inflation surged after passage of the $1.5 million tax cut by the U.S. Congress. Since then, however, rates have eased based on weaker-than-forecast data on inflation and wage growth. The 10-Year Note ended the quarter at 2.74%.

Meanwhile, investors pulled $6.5 billion from the five largest ETFs investing in high-yield (junk) bonds in the first quarter, and a widely-followed index of municipal bonds fell 1.11%, again reflecting investor fears over rising inflation and higher rates.

The Economy

The March employment report for the U.S. economy was quite strong as nonfarm payrolls increased by 313,000, well above economists’ consensus of 205,000. At the same time, wage growth was below expectations at a non-inflationary 2.6%. This reading indicates there is still slack in the U.S labor market despite the fact that the unemployment rate has held near a 17-year low.

U.S. Gross Domestic Product (GDP) growth in the fourth quarter of 2017 was revised upward to 2.9% from an initial reading of 2.6%, and many analysts think it will reach 3% by the end of 2018. In addition, earnings of S&P 500 companies are expected to grow 17% in the first quarter from the year-earlier period.

Conclusion

While economic growth and corporate earnings are improving, rising interest rates and uncertainty about Federal Reserve policy are negatives going forward. In addition, the bull market for stocks is the second-longest in history as it enters its tenth year.

As always, we will closely monitor all developments affecting your investments and keep you advised.